Q2 End Report

Author:  Joe Maas, CIO SPG Advisors LLC

Thursday, July 11th, 2024

Economic Cycle Update

Welcome to Synergy Asset Management’s Economic Cycle Assessment, our quarterly analysis of the market’s performance and our strategic outlook, based on the primary drivers of the market – interest rates, inflation, the Federal Reserve, corporate earnings, and geopolitical events. 

Every quarter, our team analyzes a list of qualitative and quantitative factors of the economy, as we assess what part of the cycle, we find ourselves in. This process allows us to adopt longer-term views on the economy and markets, which ultimately inform our portfolio positioning. 

Our second quarter economic cycle assessment identified 31 bull factors and 18 bear factors, yielding a bullish score of 63.3% and a bearish score of 36.7%. This marks a slight decrease from last quarter, as emerging cracks in economic data have become more apparent. 

Leading indicators generally suggest a neutral to bearish outlook for future economic conditions, while current and lagging indicators indicate that the US economy is currently in good shape. Our view is that the US economy is flirting between a midpoint, downturn, and recovery, and that more evidence is needed to fully understand our position in the economic cycle.

There is some indication suggesting we may be near point D, which would mean an economic and market correction ahead. At the same time, there is also evidence that we may be at a low point right now, potentially leading to a recovery in the coming quarters. Concurrently there is data to support that we may be in a recovery, near point G, heading toward a new economic and stock market high.

Uncertainty remains for the US economy, with the main question being whether the US can truly achieve a soft landing in the coming year or two. The outcome will significantly impact labor markets, inflation, domestic and global economic growth, asset prices, and a range of other macroeconomic consequences.

Historical economic cycle scores in recent quarters:

We have integrated this longer-term, strategic score into our portfolio construction process. By factoring in these market insights, we believe that our portfolios are strategically aligned to take advantage of the prevailing economic sentiment and optimize returns.
 
Below is a brief overview of some of our leading bull and bear indicators in Q2:

Yield Spreads
A narrow yield spread, close to 1%, indicates that investors are confident in the economic outlook and believe the risk of corporate defaults is low. According to Moody’s Seasoned Baa Corporate Bond Yield relative to the Yield on the 10-Year Treasury, yield spreads in Q2 2024 are near their lowest level since 2018. This suggests strong investor confidence in the US economy and a positive outlook for corporate credit risk.

Corporate Earnings
Earnings growth, particularly among the S&P 500 companies, appears to be stable on average and strong in certain sectors. Expectations for second quarter earnings growth for the index are also bullish. This demonstrates that corporations are faring well under current economic conditions.

Asset Prices
With the exception of a few sectors and asset classes, asset prices are relatively high, particularly in US large-cap stocks and real estate. This is a positive sign for the average consumer with 401k savings and homeownership, indicating favorable economic conditions. Elevated prices in these areas reflect strong market performance and contribute to consumers’ confidence in the economy.

Inflation
Although some may argue the work is not done, the Federal Reserve has made significant progress in bringing inflation closer to 2%, a trend that has continued into Q2. Some essentials, like groceries, while still much higher than a few years ago, are now experiencing inflation closer to 1%, as of the recent CPI. This is a positive trend for the economy, reflecting the Fed’s effective efforts in stabilizing runaway inflation.

ISM Manufacturing
The ISM Manufacturing Index, which tracks US manufacturing activity through a survey of over 300 manufacturers, provides a key indicator of economic health in manufacturing sector. Readings above 50% suggest expansion, while those below 50% signal contraction. Throughout Q2, the index has been in contractionary territory, consistently below the 50% mark, highlighting a bearish outlook for the manufacturing sector, especially as the index has been generally bearish since late 2022.

ISM Services 
The ISM Services Index, which surveys over 400 firms, measures US service sector activity. Similar to the ISM Manufacturing Index, readings above 50% indicate economic growth, while below 50% signal contraction. In Q2, the index fell below 50% in both April and June, following a previously strong trend. This decline points to a recently bearish trend in the services sector for the quarter.

Yield Curve
An inverted yield curve is a phenomenon that occurs when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile. The US Treasury yield curve has been inverted since 2022, reflecting bond investors’ expectations for a decline in longer-term interest rates—a view typically associated with impending recessions.

Restrictive Fed
The US’s central bank, the Federal Reserve, has maintained a restrictive monetary policy for several quarters, starting with rate hikes that began in 2022. With no rate cuts on the table yet, monetary policy remains tight, weighing on the economy as the Fed strives to bring inflation down to their 2% target.

Interest Rates

Still Waiting on the Cut
Many economists initially thought the Federal Reserve would be cutting rates by spring or summer of 2024, however that scenario now appears unlikely, with the second quarter ending without a rate cut or clear talks of cuts from the Fed.

Despite no clear indication of a cutting timeline from the Fed, market expectations still point to a September cut.  At the beginning of the quarter, the market was pricing in a 93.5% chance that the Fed would cut rates at least once before or during the September FOMC meeting. By the end of the second quarter, this probability remained relatively unchanged at 93.8%.

More specifically, as of June 30^th, the probabilities were as follows:

• 6.2% chance of two cuts by September
• 57.9% chance of one cut by September
• 35.9% chance of no cuts by September

Although market expectations ended the quarter where they started, projections did experience fluctuations throughout Q2, with mid-quarter probabilities suggesting as much as a 50% chance that the first rate cut may not come until November or later. Rate cuts, as well as the rationale behind them, will likely end up being one of the key drivers of the market’s direction in the quarters ahead.

Source: CME Group

Yield Curve
In the second quarter, the long end of the US Treasury yield curve saw a modest rise, while shorter-term yields remained relatively stable, indicating slight progress toward a less inverted curve. The 10-year yield increased by 3.81%, starting the quarter at 4.2% and ending at 4.36%. The 20-year yield rose by 3.6%, beginning at 4.45% and finishing at 4.61%. The 30-year yield climbed by 3.92%, starting at 4.34% and ending at 4.5%.
 
Despite this upward move, the yield curve remains inverted, which often signals a recession. Until the market experiences a large enough change in economic conditions, interest rates, inflation or another catalyst, it will probably remain inverted as this quarter’s progress still leaves long-term rates around 100 bps below short-term rates.

Summary

In Q2, both our economic cycle and tactical market cycle assessments remained positive, but less bullish than at the start of the quarter. This shift indicates emerging concerns in economic data, suggesting the US economy might be at a transitional point between downturn and recovery. Leading indicators generally point to a neutral to bearish future outlook, while current data shows that the economy looks to be in fair shape. Uncertainty remains regarding whether the US can achieve a soft landing, impacting labor markets, inflation, and broader economic growth.
 
Market performance was generally positive but more concentrated in Q2. The Nasdaq Composite rose +8.26% and the S&P 500 increased +3.92%, while the Dow Jones fell -0.89%. By sector, technology (XLK) and communications services (XLC) led gains with returns of +8.64% and +5.02%, respectively. In fixed income, the Barclays Aggregate Bond Index dropped -1.73% in Q2.
 
Inflation continued to improve, with CPI, Core CPI, PCE, and Core PCE showing downward trends. The Federal Reserve held policy rates steady, with market expectations for a September rate cut remaining high. Analysts believe stocks are poised for a positive earnings season ahead with Q2 results expected to grow by 4.6% in revenue and 8.8% in earnings from a year ago. Nvidia continued its strong rally this quarter but faces market and geopolitical risks. Geopolitical events and US elections could impact future economic policies and market conditions.
 
We deeply appreciate the ability to monitor markets conditions as we take tactical and strategic views on the economy in this interesting economic landscape.

Thank you,

Joseph M. Maas,
CFA, CFP®, ChFC, CLU®, MSFS, CCIM, CVA, ABAR, CM&AA

The information presented is the opinion and views of Synergy Asset Management, LLC and is for informational purposes only. Our views and presentations are not intended to serve as a substitute for personalized investment advice, and past performance is no guarantee of future results. No investment strategy or methodology can guarantee profits or protect against loss. Information and data provided is relied upon to be accurate, however, Synergy Asset Management, LLC cannot assure that data is without error or omission. Information contained herein is based on data obtained from sources believed to be reliable, however, such information has not been verified by Synergy Asset Management, LLC. This advertisement is not a solicitation or offer to buy any security or instrument, or to participate in any trading strategy or an offer of advisory services.

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